project on futures and options

8/9/2019 Project on Futures and options

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What Does FuturesMean?A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset),such as a physical commodity or a financial instrument, at a predetermined future date andprice. Futures contracts detail the quality and quantity of the underlying asset; they arestandardized to facilitate trading on a futures exchange. Some futures contracts may call forphysical deliery of the asset, !hile others are settled in cash. "he futures mar#ets are

characterized by the ability to use ery high leerage relatie to stoc# mar#ets.

Futures can be used either to hedge or to speculate on the price moement of the underlyingasset. For example, a producer of corn could use futures to loc# in a certain price and reduceris# (hedge). $n the other hand, anybody could speculate on the price moement of corn bygoing long or short using futures.

Investopedia explains Futures"he primary difference bet!een options and futures is that options gie the holder the right tobuy or sell the underlying asset at expiration, !hile the holder of a futures contract is

obligated to fulfill the terms of his%her contract.

&n real life, the actual deliery rate of the underlying goods specified in futures contracts isery lo!. "his is a result of the fact that the hedging or speculating benefits of the contractscan be had largely !ithout actually holding the contract until expiry and deliering the good(s).For example, if you !ere long in a futures contract, you could go short in the same type ofcontract to offset your position. "his seres to exit your position, much li#e selling a stoc# inthe equity mar#ets !ould close a trade.

FuturesAn agreement to buyand sellan assetat a certain date at a certain price. For example,

&nestor A may ma#e a contract !ith Farmer ' in !hich A agrees to buy a certain number ofbushels of 's corn at *+ per bushel. "his contract must be honored !hether the priceof corngoes to * or * per bushel. Futures contracts can help reduce olatilityin certain mar#ets,but they contain the ris#sinherent to all speculatie inesting. "hese contracts may be soldon thesecondary mar#et, but the person holding the contract at its end must ta#e deliery ofthe underlying asset.

What is the difference between forward and futurescontracts?

Fundamentally, for!ard and futures contracts hae the same function- both types of contractsallo! people to buy or sell a specific type of asset at a specific time at a gien price.

o!eer, it is in the specific details that these contracts differ. First of all, futures contractsareexchange/traded and, therefore, are standardized contracts. For!ard contracts, on the otherhand, are priate agreements bet!een t!o parties and are not as rigid in their stated termsand conditions. 'ecause for!ard contracts are priate agreements, there is al!ays a chancethat a party maydefaulton its side of the agreement. Futures contracts haeclearing housesthat guarantee the transactions, !hich drastically lo!ers the probability of default to almostneer.

Secondly, the specific details concerning settlement anddelieryare quite distinct.For for!ard contracts, settlement of the contract occurs at the end of the contract. Futurescontracts aremar#ed/to/mar#etdaily, !hich means that daily changes are settled day by dayuntil the end of the contract. Furthermore, settlement for futures contracts can occur oer a
http://financial-dictionary.thefreedictionary.com/buyhttp://financial-dictionary.thefreedictionary.com/Sellhttp://financial-dictionary.thefreedictionary.com/assethttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Volatilityhttp://financial-dictionary.thefreedictionary.com/markethttp://financial-dictionary.thefreedictionary.com/markethttp://financial-dictionary.thefreedictionary.com/Riskhttp://financial-dictionary.thefreedictionary.com/secondary+markethttp://financial-dictionary.thefreedictionary.com/secondary+markethttp://financial-dictionary.thefreedictionary.com/underlying+assethttp://financial-dictionary.thefreedictionary.com/underlying+assethttp://www.investopedia.com/terms/f/futurescontract.asphttp://www.investopedia.com/terms/f/forwardcontract.asphttp://www.investopedia.com/terms/d/default2.asphttp://www.investopedia.com/terms/d/default2.asphttp://www.investopedia.com/terms/d/default2.asphttp://www.investopedia.com/terms/c/clearinghouse.asphttp://www.investopedia.com/terms/c/clearinghouse.asphttp://www.investopedia.com/terms/d/delivery.asphttp://www.investopedia.com/terms/d/delivery.asphttp://www.investopedia.com/terms/m/marktomarket.asphttp://www.investopedia.com/terms/m/marktomarket.asphttp://www.investopedia.com/terms/m/marktomarket.asphttp://financial-dictionary.thefreedictionary.com/Sellhttp://financial-dictionary.thefreedictionary.com/assethttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Volatilityhttp://financial-dictionary.thefreedictionary.com/markethttp://financial-dictionary.thefreedictionary.com/Riskhttp://financial-dictionary.thefreedictionary.com/secondary+markethttp://financial-dictionary.thefreedictionary.com/underlying+assethttp://www.investopedia.com/terms/f/futurescontract.asphttp://www.investopedia.com/terms/f/forwardcontract.asphttp://www.investopedia.com/terms/d/default2.asphttp://www.investopedia.com/terms/c/clearinghouse.asphttp://www.investopedia.com/terms/d/delivery.asphttp://www.investopedia.com/terms/m/marktomarket.asphttp://financial-dictionary.thefreedictionary.com/buy


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range of dates. For!ard contracts, on the other hand, only possess one settlement date.

0astly, because futures contracts are quite frequently employed by speculators,!ho beton the direction in !hich an assets price !ill moe, they are usually closed out prior tomaturity and deliery usually neer happens. $n the other hand, for!ard contracts are mostlyused by hedgers that !ant to eliminate the olatilityof an assets price, and deliery of the

asset orcash settlement!ill usually ta#e place.

1istinction bet!een for!ards and futures-

The basic nature of a forward and future, in a strict legal sense, is the same, with thedifference that futures are market-driven organised transactions. As they areexchange-traded, the counterparty in a futures transaction is the exchange. On theother hand, a forward is mostly an over-the-counter transaction and the counterparty is

the contracting party. To maintain the stability of organised markets, market-basedfutures transactions are subject to margin reuirements, not applicable to OT!forwards. "utures market are normally marked to market on a settlement day, whichcould even be daily, whereas forward contracts are settled only at the end of thecontract. #o the element of credit risk is far higher in case of forward contracts.

*. Settlement Procedures for the Futures 2ar#et

WHYENDOFDAYSETTLEMENTISN'TALWAYSTHELASTTRADE

#ettlement price is the price at which a contract is settled at the end of the trading day.

$ith stocks this is the last trade of the day. %owever, with commodities the last trade

does not have to be the settlement price. This is important because margin

determinations are based on the settlement price.

The exchanges have a settlement committee for each commodity which meet

immediately after closing to make sure the last trade fairly represents the value for

that commodity. &sually it does but if not, a new price will be established. Actively

traded contracts have relatively stable pricing and the last trade normaly reflects the

fair value.

#ettlement price becomes more difficult for a thinly traded issue which may have last

traded ' or ( hours before the close. A complicating issue which could arise might be

a significant news story which came out shortly before the close of trading and which

has a significant impact of the price of that particular commodity. The settlement

committee will now perform an important function. They are going to try to determine
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a price for that particular commodity which fairly represents its value in light of the

news story which just broke. They may have a lot of information or very little

information to make this determination. They may be able to look at the spread

between different months or this may be of no use to them. $hatever the case, they

must determine a price which fairly represents the value of that contract)s* given thenew circumstances.

Settlement - physical versus cash-settled futures

#ettlement is the act of consummating the contract, and can be done in one of twoways, as specified per type of futures contract+

Physical delivery- the amount specified of the underlying asset of the

contract is delivered by the seller of the contract to the exchange, and by the

exchange to the buyers of the contract. hysical delivery is common withcommodities and bonds. n practice, it occurs only on a minority of contracts.ost are cancelled out by purchasing a covering position - that is, buying acontract to cancel out an earlier sale )covering a short*, or selling a contract toliuidate an earlier purchase )covering a long*. The /ymex crude futurescontract uses this method of settlement upon expiration

Cash settlee!t- a cash payment is made based on the underlyingreference

rate, such as a short term interest rate index such as 0uribor, or the closingvalue of a stock market index. The parties settle by paying1receiving theloss1gain related to the contract in cash when the contract expires.234!ashsettled futures are those that, as a practical matter, could not be settled by

delivery of the referenced item - ie how would one deliver an index5 A futurescontract might also opt to settle against an index based on trade in a relatedspot market. ce 6rent futures use this method

Currency Futures

What Does Currency FuturesMean?

A transferable futures contract that specifies the price at !hich a specified currency can bebought or sold at a future date.

Investopedia explains Currency Futures3urrency future contracts allo! inestors to hedge against foreign exchange ris#. Since thesecontracts are mar#ed/to/mar#et daily, inestors can//by closing out their position//exit fromtheir obligation to buy or sell the currency prior to the contracts deliery date.
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How to Trade Currency Futures in India

3ontributor

'y eo! 3ontributing 4riterArticle 5ating- (* 5atings)

5upee

"he &ndian economy has been expanding rapidly oer the last t!enty years,and innoations in its capital mar#ets and financial instruments haeaccelerated at a similar pace. 6o! independent traders, large financialinstitutions, trading companies, importers, exporters, and commercial hedgershae a fully functioning system for buying and selling &ndian 5upees all oerthe !orld. 0earn the steps that can be ta#en to successfully trade currencyfutures in &ndia.

Step by Step Instructions

"hings 7oull 6eed- 'ro#erage account

Step *

8nderstand the &ndian currency futures mar#et. "he mar#et is primarilyfocused on the exchange rate relationship bet!een the 8S 1ollar and&ndian 5upee. 8nli#e spot foreign exchange, in !hich one currency is

bought against the sale of the other, &ndian currency futures allo!traders to bet on the anticipated direction of one currency !ithout shortselling the other. &ndian currency futures are traded domestically on the6ational Stoc# 9xchange, in 2umbai, and internationally on 1ubai:old and 3ommodities 9xchange, based in 1ubai.

Step

$pen a bro#erage account . 7ou could either open an &ndian futuresbro#erage account, !ith an outfit li#e


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trading. 5ichcomm :lobal Serices is another bro#erage that offersaccess to &ndian currency futures. 'e a!are that if you use an &ndianbro#er, all of your trading capital !ill probably hae to be denominatedin 5upees, exposing you to exchange rate ris# if the 5upee !ere tosignificantly lose alue relatie to the 1ollar.

Step >

Study and follo! the fundamental factors that affect the price of the&ndian 5upee in relation to the 8S 1ollar and other internationalcurrencies. "he primary driers of price change are interest ratefluctuations, and the factors that hae the greatest impact on interestrates, such as :1? gro!th, inflation, trade balances, and internationalmoney flo!s. @eep trac# of factors that affect both the 5upee inabsolute terms, as !ell as relatie to the 8S 1ollar.

Step

'ecome acquainted !ith technical analysis, and use it to decide on!hen to buy and sell &ndian currency futures. "echnical analysis is theuse of price charts and indicators to better predict !hat prices !ill bedoing in the future. &t can help you better determine if the 5upee isoeralued or underalued relatie to the 1ollar, and at !hat price youmight consider entering a long or short position in the currency futuresmar#et.

Step +

&mplement a comprehensie ris# and money management plan. &ndiancurrency futures, li#e all futures contracts, are high ris#, high re!ardinstruments, and if you trade !ithout stop losses, theres a ery goodchance youll eentually get caught on the !rong side of a big moeand lose your entire account. 4hen ma#ing a trade, al!ays #no!exactly ho! much youre !illing to lose ahead of time, as !ell as at!hat price you !ill be stopped out of the trade.

Definitions

(i) 3urrency Futures means a standardised foreign exchange deriatie contract tradedon a recognized stoc# exchange to buy or sell one currency against another on aspecified future date, at a price specified on the date of contract, but does not include afor!ard contract.

(ii) 3urrency Futures mar#et means the mar#et in !hich currency futures are traded.

Perission

(i) 3urrency futures are permitted in 8S 1ollar / &ndian 5upee or any other currencypairs, as may be approed by the 5esere 'an# from time to time.


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(ii) $nly Bpersons resident in &ndiaC may purchase or sell currency futures to hedge anexposure to foreign exchange rate ris# or other!ise.

Features of Currency Futures

Standardized currency futures shall hae the follo!ing features-

a. $nly 8S1/&65 contracts are allo!ed to be traded.b. "he size of each contract shall be 8S1 *.c. "he contracts shall be quoted and settled in &ndian 5upees.d. "he maturity of the contracts shall not exceed * months.e. "he settlement price shall be the 5esere 'an#Cs 5eference 5ate on the last tradingday.

Participants

(i) 6o person other than a person resident in &ndia as defined in section () of theForeign 9xchange 2anagement Act, *DDD (Act of *DDD) shall participate in the

currency futures mar#et.

(ii) 6ot!ithstanding sub/paragraph (i), no scheduled ban# or such other agency fallingunder the regulatory purie! of the 5esere 'an# under the 5esere 'an# of &ndia Act,*D>, the 'an#ing 5egulation Act, *DD or any other Act or instrument haing the force ofla! shall participate in the currency futures mar#et !ithout the permission from therespectie regulatory 1epartments of the 5esere 'an#. Similarly, for participation byother regulated entities, concurrence from their respectie regulators should beobtained.

Mebership

i. "he membership of the currency futures mar#et of a recognised stoc# exchange shallbe separate from the membership of the equity deriatie segment or the cash segment.2embership for both trading and clearing, in the currency futures mar#et shall be subEectto the guidelines issued by the S9'&.

ii. 'an#s authorized by the 5esere 'an# of &ndia under section * of the Foreign9xchange 2anagement Act, *DDD as BA1 3ategory / & ban#C are permitted to becometrading and clearing members of the currency futures mar#et of the recognized stoc#exchanges, on their o!n account and on behalf of their clients, subEect to fulfilling thefollo!ing minimum prudential requirements-

a) 2inimum net !orth of 5s. + crores.b) 2inimum 35A5 of * per cent.c) 6et 6?A should not exceed > per cent.d) 2ade net profit for last > years.

"he A1 3ategory / & ban#s !hich fulfill the prudential requirements should lay do!ndetailed guidelines !ith the approal of their 'oards for trading and clearing of currencyfutures contracts and management of ris#s.

(iii) A1 3ategory / & ban#s !hich do not meet the aboe minimum prudentialrequirements and A1 3ategory / & ban#s !hich are 8rban 3o/operatie ban#s or State3o/operatie ban#s can participate in the currency futures mar#et only as clients, subEectto approal therefor from the respectie regulatory 1epartments of the 5esere 'an#.

Position !iits


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i. "he position limits for arious classes of participants in the currency futures mar#etshall be subEect to the guidelines issued by the S9'&.

ii. "he A1 3ategory / & ban#s, shall operate !ithin prudential limits, such as 6et $pen?osition (6$?) and Aggregate :ap (A:) limits. "he exposure of the ban#s, on their o!naccount, in the currency futures mar#et shall form part of their 6$? and A: limits.

"is# Mana$eent Measures

"he trading of currency futures shall be subEect to maintaining initial, extreme loss andcalendar spread margins and the 3learing 3orporations % 3learing ouses of theexchanges should ensure maintenance of such margins by the participants on the basisof the guidelines issued by the S9'& from time to time.

%urveillance and Disclosures

"he sureillance and disclosures of transactions in the currency futures mar#et shall becarried out in accordance !ith the guidelines issued by the S9'&.

&uthorisation to Currency Futures 'xchan$es ( Clearin$ Corporations

5ecognized stoc# exchanges and their respectie 3learing 3orporations % 3learingouses shall not deal in or other!ise underta#e the business relating to currency futuresunless they hold an authorization issued by the 5esere 'an# under section * (*) of theForeign 9xchange 2anagement Act, *DDD.

Powers of "eserve )an#

"he 5esere 'an# may from time to time modify the eligibility criteria for the participants,modify participant/!ise position limits, prescribe margins and % or impose specific

margins for identified participants, fix or modify any other prudential limits, or ta#e suchother actions as deemed necessary in public interest, in the interest of financial stabilityand orderly deelopment and maintenance of foreign exchange mar#et in &ndia.

Advantages of Futures Contracts

If price moves are favourable, the producer realizes the greatest return with this

marketing alternative.

No premium charge is associated with futures mar#etcontracts.

Disadvantages of Future Contracts

Subject to margin calls

Unable to take advantage of favourable price moves

Net price is subject to Basis change

trading volume

ide links within definitions

Definition

!he number of shares, bondsor contractstraded during a givenperiod, for asecurit"or an

entire e#change. also calledvolume.
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*olue

What Does VolumeMean?"he number of shares or contracts traded in a security or an entire mar#et during a gienperiod of time. &t is simply the amount of shares that trade hands from sellers to buyers as ameasure of actiity. &f a buyer of a stoc# purchases * shares from a seller, then the olumefor that period increases by * shares based on that transaction.

Investopedia explains Volume=olume is an important indicator in technical analysis as it is used to measure the !orth of amar#et moe. &f the mar#ets hae made strong price moe either up or do!nthe perceied strength of that moe depends on the olume for that period. "he higher theolume during that price moe the more significant the moe.

Tradin$ Futures+ ,nline Futures Tradin$+ FuturesTrade

"utures trading is a form of investment involving speculation ofthe price of a commodity in the future. "utures are derivatives bought or sold on a

futures exchange. They are contracts to buy or sell a particular amount of acommodity at a predetermined price on a specified date in the future. Tradi!" #$t$resis not for newcomers to investing, since it involves high risk.

The majority of futures trading is speculative and involves cash settlements )alsoknown as paper investing*, rather than for the actual physical delivery of thecommodity. Online futures trading is not as popular as online stock trading, since theformer is substantially more risky.

Till the 789:s, futures trading comprised of only a handful of farm products. Thepopularity of the futures market subseuently rose and in the ;7st century it involves a

huge variety of commodities, including+

metals $ like gold, silver and platinum. livestock % such as pork bellies and cattle.

energ" $ like crude oil and natural gas. foodstuffs % such as coffee and orange juice. industrial products $ like lumber and cotton.

currencies. indices $ such as the &ow 'ones, Nasda( and S)* +.

Trading Futures: What does it Involve?

There are two aspects that distinguish futures trading from trading in stocks or bonds.


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- futures contract has a specified lot size. So, there could be a futures contract of

shares of IB/ or + shares of 0isco S"stems. 1ou could also opt for an inde#. 2or instance,

one could opt for purchasing the 3$mini S)* + futures contract. !his gives "ou e#posure toall the stocks in this inde#.

1ou can trade with margin pa"ment. !his means that when "ou purchase a futures

contract, "ou do not have to pa" the entire amount of the contract. 1ou onl" need to pa" a

specified margin amount. 2or instance, "ou could purchase a futures contract for shares of IB/ worth 45 per share at a 56 margin. !his means thatinstead of pa"ing 4,5 7 # 458, "ou need to pa" onl" 459 756 of 4,58. !hisoffers substantial leverage to the investor.

Benefits of Trading Futures

Among the benefits of trading futures are+

igh leverage

igh li(uidit"

:ow brokerage fees

Dangers of Trading Futures

The main risk involved in trading futures is that it is a highly speculative market.

Tradin$ futures contracts

"o trade futures you open an account !ith a futures bro#erage firm #no!n as a futures commissionmerchant (F32), !ho !ill execute and record your trades, and monitor and adise you of yourar$inaccountobligations. 7ou may deal !ith the F32 directly or go through an introducing bro#er (&') orcommodity trading adisor (3"A). As !ith stoc#s and bonds, you pay commissions and fees to tradefutures.

7ou gie your bro#er an order to buy or sell a futures contract, either to open a ne! position or to offsetand cancel an existing position. 7our bro#er in turn transmits the order to the appropriateexchan$efloor orelectronic tradin$ syste.

7ou may also inest in futures through a commodity pool, !hich resembles a mutual fund. 7ourinestment is pooled !ith assets from other inestors, and the commodity pool operator (3?$) tradesfutures contracts using those funds. $r, you may !or# !ith a commodity trading adiser (3"A), to !homyou gie authority to trade in your account. 'oth 3?$s and 3"As are typically paid based on theirperformance.

Tradin$ in action

"raditionally, futures !ere traded using the open outcryauction method on exchange floors diided intotrading pits. "oday, more and more trades are executed electronically, and trading in some commoditiesis entirely electronic. $n some exchanges, electronic trading systems operate alongside lie trading. $nothers, open outcry occurs during the day and e/trading on those commodities ta#es place during theeening and oernight. $ther exchanges are entirely electronic, !ith no trading floor at all.


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Mar#in$ to ar#et$er their term and een throughout a typical trading day, futures

contracts change alue. At the end of each trading day, the

exchanges clearin$house!ill either credit your account !ith profits

or require you to add more money to bring your margin account up to

the appropriate leel. "his process is called daily cash settlement, or

ar#in$ to ar#et.

!evera$e a$nifies

"he ability to buy a futures contract !ith a good faith deposit or initial

ar$inof * or less of the underlying commoditys alue appears

to gie an inestor a lot of buying po!er. "he initial amount required

to open a futures position seems relatiely small. For example, you

might buy a gold contract !ith the follo!ing terms-

Guantity H * troy ounces

1eliery month H February

?rice in dollars per ounce H >+2inimum tic#H * cents per troy ounce, * per contract

For only a >,+ initial margin, you !ould control a >+,

inestment in a futures contract for gold. &f the price !ent up + to

per ounce, the alue of the futures contract !ould increase by+, to ,.

"hat increase represents a *,+ paper gain on the initial margin of

>,+. $n the other hand, if the price dropped +, the alue of the

futures contract !ould drop +, to >,, and you !ould hae

to add *,+ to your margin account to coer the loss in the

contracts alue.

&n a olatile mar#et, leeraged inesting magnifies the effect of price

changes.

Tradin$ positions"here are t!o sides to eery futures contract H an inestor !ho has a lon$positionand an inestor!ith a shortposition. And inestors in the futures mar#et irtually al!ays ta#e both long and shortpositions, as they buy or sell contracts to offset existing positions. So a typical inestor !ill be a long insome contracts and a short in others.

"hats not the case in the stoc# mar#et. A typical stoc# mar#et inestor ta#es a long position H buyingstoc# to sell at a higher price at some future date. %ellin$ shortis a higher ris# strategy that only a

percentage of stoc# inestors employ, hoping to ma#e money on stoc#s that are losing alue. "o sellshort, inestors borro! shares they dont o!n and sell them. "hen they !ait for the price of the stoc# todrop so they can buy the shares at the lo!er price to replace the borro!ed shares (plus interest andcommission). "he longer the price ta#es to drop, the higher the interest charges o!ed to the bro#er, andthe less profit possible.

&n a futures contract, the short may buy an offsetting contract at any time before the expiration of thecontract term. 'ecause the futures contract is a future obligation, nothing is borro!ed and interestpenalties do not accrue.

Types of futures orders

4hen you place an order for a futures contract at the best price offered, the order is a ar#et order."he price at !hich its executed may be seeraltic#sa!ay from !hat the price !as !hen you placed


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the order. So you !ont #no! the price you paid until the order fulfillment is reported bac# to you.

Contin$ent orders

"o sole the inherent uncertainty of a mar#et order, you may also place restrictions on ho! an order is tobe filled. "he most common contin$ent orderis the liit order. A limit order places a restriction on theprice at !hich a contract may be bought or sold H sell orders!ill be authorized only at or aboe the

liit priceandbuy orders!ill be authorized only at or belo! the limit price. 8nless other!iseindicated, a limit order is also a day order, so that if it has not been filled by the end of the trading day, itexpires. :ood/til/canceled (:"3) or open orders, on the other hand, do not expire until they are filledor cancelled.

"here is a range of other contingent orders possible. 2ar#et/if/touched (2&") orstop orderstriggerbuying or selling if substantial mar#et olatility sends prices in a certain direction. 2ar#et/on/close(2$3) and mar#et/on/open (2$$) orders stipulate buying or selling at the mar#ets open or close.

How futures tradin$ wor#s2ost producers and users of commodities buy and sell them in the cash ar#et, also called the spotmar#et, because the full cash price is paid on the spot. 3ash prices are determined by supply anddemand, !hich in many cases moe in predictable seasonal cycles. Fresh fruits and egetables arecheapest in the summer !hen theyre plentiful (and most flaorful). So soup, Euice, and Eammanufacturers plan their production season to ta#e adantage of the highest/quality produce at thelo!est prices.

'ut supply and demand is also affected by unpredictable eents. 1rought might !ipe out a !heat crop,causing the cash price of !heat to soar. ?olitical turmoil in the :ulf region might threaten the oil supplyand cause the cash price of energy commodities to rise. "he futures mar#et is designed to help protectproducers and users from Eust such price ris#s. Farmers, loggers, manufacturers, and ba#ers can buyfutures contracts in the products they produce or use to smooth out the unexpected price fluctuations.

%upply and deand+ plus expectations

Futures prices tend to trac# cash prices closely, but not identically. "he difference bet!een the futurescontract price and the cash price of the underlyin$ coodityis the basis. Futures prices aredetermined not only by supply and demand, but also by traders expectations of a host of other factors,including !eather changes, enironmental conditions, political situations, and !hat the mar#et !ill bear.

TYPESOFF%T%RESTRADIN&CONTRACTS

There are mainly two types of futures trading contracts. They are futures contracts

which are traded for physical delivery, known as commodities and futures contractwhich are end with a cash settlement, known as financial instruments. 6oth types offutures contracts are traded electronically and directly.

"utures contracts which are traded for physical delivery includes agriculturalcommodities like wheat, oats, sugar etc, energy products like crude oil, heating oil,natural gas etc, or animals. /ote that very commodity futures contracts actually end indelivery. Often these contracts are traded just like shares of a stock market, accordingto the changes in price trends. Online futures traders include both speculators andhedgers.

"utures contracts which are traded for cash settlement involve treasury notes, bonds,


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etc. These futures are also known as currency futures and are often traded just likecommodity futures though electronic platforms.

Fi!a!cial #$t$resare futures contract based on financial instruments such asTreasury bonds, currencies and !ed contracts that are traded in organi>ed futuresexchanges across the world. The mode of trade is open outcry on the floor of theseexchanges. 0xamples include the nternational oney arket in !hicago and ?ondonnternational "inancial "utures 0xchange )?""0* in ?ondon.

The contractual agreement stipulates the terms of the agreement such as the numberof units of the financial instrument, the names and details of the parties to thecontract, the futures price and the specified future delivery date. The transfer of profitsor losses accrues on the basis of the difference between the settlement price and thefinancial futures price.

"or instance, a buyer who purchases a @une '-month 0urodollar contract iscommitting to deposit 7 million 0urodollars in @une for ' months. Additionally, the

deposit would be done at an interest rate that is agreed upon at the time of thecontract. The actual procedure, however, depends on the exchange in which thetrading is conducted. The movements of the price are tracked in terms of ticks,Bwhich represent the minimal price fluctuations.

The buyers or sellers of the futures contract are reuired to deposit an initial amountcalled the margins. This is deposited with the clearing house of the futures exchange.This is a fixed amount which is held with the futures exchange till the position is held.

Benefits of Financial Futures

"inancial futures are hedging instruments that can help reali>e high profits and protectagainst risks. oreover, financial futures offer the following+

igh li(uidit".

-n opportunit" to avoid the actual transfer of financial instruments.

Risks of Financial Futures

The risks associated with financial futures are+

igh losses are possible if investors overtrade or trade without a plan. Insider trading can be a problem in futures trading, which can harm the profit prospects

of other traders.


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nvestors with a high risk appetite tend to like financial futures and their potential forshort term profits.

Cdity #$t$resaim to transfer risks associated with the ownership of acommodity. The commodity may be anything, from wheat to a foreign currency. Atthe time of the futures contract, the actual commodities do not physically changehands. The contract is legally binding for the transfer of commodities at a future date,which is specified at the time of entering into the contract. Also, at that moment itself,the price at which the delivery would take place in the future, is decided.

How are Commodit Futures Traded?

!ommodity futures trading are done in an organi>ed futures market. &nlike otherinvestments such as stocks and bonds, trading in futures does not involve the actual

possession of the commodity. All an investor does is to speculate on the futuredirection of the price of that commodity.

A well organi>ed and efficient commodities futures market is acknowledged ashelpful for the price discovery of commodities that are traded in it. #uch a marketfacilitates the offsetting of transactions without actually impacting the physical goods.

$hen commodity futures contracts are traded with high leverage, they fall in the highrisk area and get close to speculation. %owever, such kind of trading can also be doneusing low leverage to provide favorable payoffs. This techniue would place futures

trading in the low risk spectrum.

Benefits of Commodit Futures !hrough commodit" futures trading, it is possible for investors to make huge profits

with limited capital. Sometimes it happens even in a short period of time.

&ue to its features, the commodit" futures market attracts hedgers since the" can

minimize their risks. !he market also encourages competition among the traders who have

the market information and price judgment.

Commodit Futures: Risks Involved

Often, some investors trade in commodity futures to get rich uickly. #uch investorsare prone to losing money as they take big risks which might go against them. Tradingin commodity futures is risky if it is treated as merely a speculative market. t isadvisable for investors to exercise patience while making investing decisions.


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What is a Currency Future?

!urrency "utures are traded in the same manner as any other form of futures contract.%owever, instead of dealing in a tangible product like pork bellies or wheat, theexchange rate between two given currencies serves as the commodity for the

underlying contract.

There are two ways to settle a currency futures contract C you can hold it untilmaturity at which point you receive a cash settlement at the rate specified in thecontract, or you can buy and sell currency contracts prior to maturity on anestablished exchange. There are several exchanges that speciali>e in currency futuresincluding the !hicago ercantile 0xchange )!0*, 0uronext, and the Tokyo"inancial 0xchange to name a few of the larger currency futures trading centers. #ee#ettlement and


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Pricing Currency Futures Contracts

!ontract prices for currency futures are determined by the interest rate for the countryof origin for the currencies listed in the futures contract as well as the spot rates foreach currency. 6y incorporating the spot rates in the contract price calculation, the

ability to profit solely on arbitrage differencesis eliminated as the contract pricemoves in tandem with fluctuations in the spot rate of either currency.

Nte( Arbitrage occurs when the same currency or commodity is listed onmore than one exchange at the same time. f the price changes on oneexchange but lags behind the other, an opportunity exists to profit onthe difference between the two exchanges C this is known as arbitragetrading.

"or example, if the value of the 0uro were to rise in the spot currencymarket but the increase was not reflected in the futures market, anarbitrage opportunity would result as the futures price would still be

based on the weaker 0uro valuation. Traders could use this informationto buy futures contracts that, in effect, were priced on stale data. 6yupdating futures prices with changes in the spot market, the ability toexploit market arbitrage is greatly reduced.

The following formula is used to set the price for a contract for a given currency pair+

" E # )7 F =G x T* H )7 F =6 x T*

$here+

FE the price for the currency futures contract

SE the spot rate for the currency pair R)E the interest rate of the uote currency

R*E the interest rate of the base currency

TE the tenor or time to maturity )in days*

6ecause contract prices are determined C i.e. derived C from the underlyingcurrencies, currency futures are considered a derivatives product. !urrency futurescontracts are similar toforward rate agreements )"=As*and can also be used forhedging and speculation purposes.%owever, unlike "=As which are agreements

between two parties with terms as agreed to by both parties, currency futures havestandard maturity dates and are offered in fixed amounts only.
http://www.fxpedia.com/FXGlossary#arbitragehttp://www.fxpedia.com/Forward_Rate_Agreementshttp://www.fxpedia.com/Forward_Rate_Agreementshttp://www.fxpedia.com/Forward_Rate_Agreementshttp://www.fxpedia.com/Exchange_Rate_Hedgehttp://www.fxpedia.com/Exchange_Rate_Hedgehttp://www.fxpedia.com/FXGlossary#arbitragehttp://www.fxpedia.com/Forward_Rate_Agreementshttp://www.fxpedia.com/Exchange_Rate_Hedge


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MINIM%MPRICECHAN&E

rice changes in currency futures are expressed as pips or somewhat less commonly,as ticks. A pip C short for percentage in point C is the smallest unit of measure atwhich the currency pair trades. "or example, if the current exchange rate forA&


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I;::,::: )I7:,::: x ;:* thus enabling you to secure greater profits on even smallprice movements.

Of course, this can work against you as well. f you have committed all your available

cash to a trade and the value of the trade falls below your maintenance margin level,you will receive a margin call reuiring you to deposit additional margin to youraccount.

"or example, consider the following scenario where an investor intends to buy asingle < 1 !A< currency futures contract+

< 1 !A< currency futures contracts are listed in I7::,::: !A< lots

One contract is currently valued at I:.83:: !A< per &.#. dollar, orI83,:::

project on futures and options

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